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Endeavour International Corporation (NYSE:END)

Q3 2009 Earnings Call

November 4, 2009 10:00 am ET

Executives

Mike Kirksey - CFO

Bill Transier - CEO

John Williams - EVP of Exploration

Carl Grenz - EVP of Operations

Analysts

Leigh Curry - Guerrilla

Operator

Good day ladies and gentlemen, and welcome to the Third Quarter 2009 Endeavour International Corporation Earnings Call. My name is Anne, and I will be your coordinator for today's call. (Operator Instructions) As a reminder, this call is being recorded for replay purposes. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session following the presentation. I would like to turn the presentation over to Mr. Mike Kirksey, Chief Financial Officer.

Mike Kirksey

I'm Mike Kirksey, the Chief Financial Officer. I'm joining you from Houston, Texas today. Also on the phone with us from London is Bill Transier, our Chief Executive Officer, John Williams our Executive VP for Exploration, and Carl Grenz, our Executive VP for Operations.

Before we start today, let me remind everyone that this presentation contains our best estimates; however, a number of factors can cause actual results to differ materially from what we present today. For the risk factors associated with our business, you should read our full disclosures and our latest 10-K and the 10-Qs. We do expect to file our third quarter 10-Q later this week. For some opening comments, let me turn it over to Bill Transier.

Bill Transier

Welcome to all of you. I hope that you had a chance to look at our earnings release that went out last night. As you can tell, the third quarter was a tough quarter. This was the first full quarter that we had without our Norwegian operations. More importantly, we had significant unplanned downtime at Goldeneye, Enoch, and Bittern, and our liftings this quarter primarily related to the lower volumes were down fairly significantly from comparative quarters in the past.

Looking forward to our operations in the fourth quarter and beyond, I will tell you that our operations team, which Carl has built has made a real substantive impact on the operators of these assets that we're involved with, and we're now seeing positive results which we think will take effect and be consistent going forward. We're back on production, and all of our assets' without loss of either rate or reserves.

The good news for Endeavour going forward is the developments at Rochelle, Cygnus and Columbus are on track and you'll hear more about that from Carl in a few minutes. Our exploration has continued its successful record with more planned activity yet to come this year and early in the next year. The Wolfcamp resource play in Southern New Mexico is now starting to gain traction and add oil production for us in the U.S. And with the fall out of the independent sector over here in the U.K. primarily for financial reasons, Endeavour really kind of stands alone and is on track to be the largest independent gas producer in the North Sea by mid-2011.

Now I'd like to turn over the call, and Mike will walk you through our financial results, then Carl will discuss our development projects in the U.K. and our production. John will come next and discuss our exploration and appraisal activities and give you more information on this Wolfcamp play, and then I'll come back to you with some comments about our business development activities and some comments about Endeavour's strategy.

Mike Kirksey

The third quarter financial results are all about volumes, as Bill mentioned. As you can see on the tables attached to the press release, volumes were about half of last year, and a similar drop compared to Q2.

As we stated in our second quarter conference call, we expected Q3 volumes to be down from planned maintenance as is normal this time of year. In fact, we had more downtime than planned. We experienced 95 days of downtime in the third quarter on our various producing assets compared to 22 days in the second quarter and 69 days last year in the third quarter.

Goldeneye, our biggest producer was down 37 days, more than double last year's Q3 downtime. Much of this was planned, but the extended downtime on Goldeneye was not planned and impacted the third quarter. Goldeneye is back on stream now at previous production rates, as are all of our producing assets. Carl will cover this in more detail in a moment.

Lower production volumes impacts gas revenues of course, and impacts tanker liftings which drives our oil revenue number. There were three oil liftings from our producing fields in the third quarter, compared to seven liftings in the second quarter, and we expect six liftings in the fourth quarter. Therefore, we expect the fourth quarter to return to more normal financial levels.

While market prices for oil and gas were significantly down from last year, hedges continue to be an important tool for us, generating a cash gain of 7.5 million, basically recovering all the drop in pricing from last year's results. Our hedging position continues to be robust with approximately 95% of our oil of our '09 at about $85 and excellent gas hedges in place for this year and next at approximately 55 pence per therm, as they measured in the U.K.

As we said, our last quarter CapEx was frontend loaded in 2009 and we expect the remaining of '09 that our cash flow will fund any CapEx plans.

From a balance sheet standpoint, we find Endeavour well positioned with almost 80 million in cash to move forward with our plans and to take advantage of opportunities that may arise, as we did with the announcement of our purchase of producing properties in the last week.

As we mentioned previously, Endeavour has paid down debt of $65 million this year. Our mid-year redetermination of our borrowing base has been completed with no pay downs required for the remainder of the year. Actually, we are working to expand our borrowing capacity significantly by adding a development facility typical in the U.K. North Sea.

We are heavily engaged with our lead banks BNP Paribas and Lloyd's to structure facility targeting a 100 million in additional capacity to support our ongoing growth and development efforts in the North Sea.

We have spoken to most of our banks individually and have received indications of support for this process. The addition of this facility along with existing cash and next year's cash flow gives us a path to turning on our U.K. development assets, our number priority.

Our production forecast for the year remains as previously communicated, in fact with the additional production, we acquired last week, we should be at the top of the range.

Now just to give a few details. The average market price on a barrels of oil equivalent basis in Q3 was half of last year at $41 compared to $92 a year ago. Oil specifically increased in average price in the third quarter to $62 compared to $51 in the second quarter. While U.K. gas declined in price from $464 Mcf to $4.10. The quarter ending U.K. gas price was 20 pence per therm or about $3.20.

Subsequent to year end, gas prices have improved to 30 pence a therm, but as I mentioned previously, our hedges for gas this year and next are at about 55 pence a therm, so our hedges continue to be very solid benefit for Endeavour.

During the third quarter, our hedges had realized gains in both commodities totaling 7.5 million, 3.8 million in oil and 3.7 million in gas, resulting in an overall improvement to our average realized price of almost $40, increasing our net realized price on barrels of oil equivalent to $80.

Operating cost and DD&A were both down in Q3 on volumes. The metrics per barrel were abnormal because of the volumes and the inclusion of certain fixed and straight line depreciation components of these expenses.

Again, we expect Q4 to return to the normal metrics as we've given in our guidance. The non-cash mark-to-market charge was due to rising oil prices, thereby decreasing the value of our hedges when compared to the second quarter.

As we stated in the last quarter, our other income and expense line includes foreign currency translation activity. In the third quarter there was a gain of about $2 million resulting from a slightly weaker sterling.

Year-to-date, the other income and loss item of 6.9 million is primarily translation losses at year-to-date.

So with those details, the results for the quarter as I said were driven by volumes, but production has recovered. We expect the fourth quarter to be back to normal production levels and normal metrics. We believe we're positioned on our balance sheet and ongoing discussions with our bank group to continue our progress in North Sea and to take advantage of opportunities that arrives as we did last week.

Let me turn the call over to Carl, for some comments on our development projects.

Carl Grenz

Thank you, Mike. This is Carl Grenz, EVP, Operations. I'll start with developments and talk about Rochelle first. I can report that there has been excellent progress made on Rochelle in the last quarter with very strong progress made on all fronts highly competent and experienced project team have now selected the field development concepts on the basis of design.

All our engineering works that's the facilities engineering and reservoir engineering work has progressed on track and this has allowed us now to progress into the feed stage of the projects, that's the frontend engineering and design stage, so everything going well there.

The Field Development Plan or FDP and associates at environmental impact assessment are both nearing completion and ready to be submitted to the government's Department of Energy and Climate Change or DECC, early in December 2009.

Now, this is clearly significant milestone in the progression of the project and the thought that we are submitting the FDP, we're going to say that we have complete alignment with our joint venture partner Nexen, who are aligned with the designing the schedule for Rochelle.

Also through our effective communication strategies, we have taken both the DECC and the relevant NGOs along with us on this journey, so we’re anticipating a smooth and rapid approval of the field development plant early in 2010.

From the commercial perspective, we have been working very cooperatively with the preferred host, the facility that we expect to export our gas two, looking details of the required topside modification etcetera and we expect to have an indicative tariff agreement in place with the host owners before the end of this year.

I have mentioned that the engineering work is progressing very well, but I should mention as we compile the installation start-up schedule for the project, we’ve realized that we would be completing the subsea installation inside the winter period late in the fourth quarter of 2010. Now as I am sure you will be aware that weather in this area of the North Sea has pretty ugly winter.

So what we have done? We have taken a very hard look at this and we’ve taken the prudent decision to remove HSE and cost risk from the schedule by planning to complete the subsea installation in the second quarter of 2011, i.e. after the winter weather period is subsided. Clearly we want to have the safe and environmental issue free operation and not destroy value through weather related downtime will breaking of equipment etcetera, particularly as this is Endeavour’s first operated project.

Production is now expected to start up in the second quarter of 2011. As we work hard to balance and mitigate project risk in this way, we’re actually confident by making the schedule change will actually be adding present value to this development.

Making this change, it will also mean that we can thoroughly test all our control equipments, for example over the winter period, so that we hit the ground-running in the spring to expedite commissioning and start-up. So in short, we’re very happy with the excellent progress made to date on Rochelle.

Next, I will talk about the Cygnus development. We continue to be quite excited about Cygnus. Our two partners in this developments are both major utility companies and we’re all in [lot stake] in how to progress this development, and of course part of our excitement is that this is long life development for us and it will stretch out to and maybe beyond [2040]. If the western half of this area proves up to per expectations, we could be seeing daily production approaching 200 million cubic feet a day in gross terms.

So from a project perspective, excellent progress has been made on this development too in the last quarter in securing an export host facility. We now have no less that four hosts that we received commercial office from and the joint venture partners are working diligently to select one of these and the great commercial terms before the end of 2009.

Also, substantive facilities and service engineering work has been progressed in this last quarter, the project now has three distinct phases and we are on track to have Phase I online by the middle of 2011. Phases I and II of this development are associated with the eastern half of the area, which has already been appraised. However, the size and shape if you will of the second phase facilities are actually contingent on the appraisal wells that will be drilled in the western areas of development in the first half of 2010. John Williams will speak more about this in his exploration section to follow.

The kind of thing I am talking about is how big will be gas compression facilities need to be to accommodate production from the western area. We anticipate that Phase II could be online as early as mid 2012 with Phase III the following year, but as I said this is largely contingent on the outcome of this western area appraisal drilling and we’ll obviously be speaking more about that in subsequent earnings release calls.

As with Rochelle, we’re keeping the DECC well informed of progresses we go on this developments and they have indicated to us to a ‘letter of confesses’ its call that they are happy with the field development plan submitted earlier in the year, but it is subject to selecting our export host. This is very strong and clear indication from the government that the FDP approval will be given on this development in the first half of 2010.

Moving now on to Columbus, the third of our development projects, we can now report the significant progress has been made on the selection of our host facility to export our gas two. The joint venture partnership is working hard or rationalizing the conceptual engineering associated with this host that we’ve actually received a commercial offer from and we are hoping to have this initial engineering work completed, so the host can be confirmed by the end of this year. As you realize, this is a significant turning point in progressing this relatively simple two well tie-back development, and this time we anticipate production start up to be sometime in 2012.

So that's our three development projects. I'd now like to turn to production to make some comments on production. As Mike has already indicated, the third quarter in the production cycle in the North Sea is traditionally lower as compared to other quarters, and this is obviously due to the fact that most operators are doing maintenance work in this good weather period. This year has been no exception, and as has already been stated we've seen plant production downturns from Alba, Bittern, and Enoch.

Now whilst production in August and October actually exceeded our forecast, we did have a technical problem on Goldeneye, which is currently our most prolific producer, and that caused it to be shut down most of September. This technical problem was electrical and very complex in nature, and associated with the depletion compressor system of the St. Fergus Terminal. Endeavour was very closely involved with the remediation of this problem, and I'm happy to say that through our intervention, we were not only able to help the operator fix the immediate problem, but we have also provided design and maintenance related improvements that have actually been accepted by the operator to prevent a recurrence of this problem. We are confident that once these improvements have been implemented soon, we will improve the overall reliability of the Goldeneye development.

I am also delighted to say that we're now posting significant early production from our U.S. assets, and in addition to our Garwood well which has been online since the end of '08, we're now seeing production from the first of our New Mexico Wolfcamp wells, mainly Lucky Penny and Moore Bailout, and both of these wells are still in the post [wrap-cleanup] stage. The third one in the series, Bada Bing is expected to be online before the end of the year too. As we've recently announced, as Mike mentioned, from the 1st of November we're posting production of 650 barrels of oil equivalent per day from the acquisition in JW Operating Company in Louisiana and East Texas.

So with that, I'd like to pass on now to John Williams.

John Williams

Thanks, Carl. I'd like to go through the exploration and appraisal drilling for the U.K. and the U.S. I'd like to begin with the U.K. drilling where we'd be drilling four exploration and appraisal wells.

First well I'd like to talk about is the Deacon well. This is a prospect in the Central North Sea in Block 15/28. It's in our R-Block focus area, containing the assets Rubie, Renee, and Rochelle. This is a Nexen farm-in. Nexen is also our partner in the Rochelle development that Carl just mentioned. We took a 10% working interest in the project. It's a stratigraphic prospect having a Jurassic reservoir encased in [Cameron] source rock. There's excellent seismic data that's provided a very good impedance model showing the reservoir encased in the shale. Medium risk, has got a proximal analog called Tweedsmuir field just to the west, seven or few miles, and we expect to spud as early as fourth quarter 2009. Our estimated Pmean gross potential of the prospect is 60 million barrels gross, and it's going to cost us about $4.8 million net exposure for drilling it.

The Western side, this other phase, has additional potential and could take the total reserves of the Cygnus field up to 1 trillion cubic feet gross. If we make the trillion cubic feet of gross, Cygnus would be in the top ten fields in terms of volume of all the fields ever drilled in the Southern North Sea, U.K., which is significant, considering the maturity of the basin.

Previous appraisal wells that we've drilled last year had flowed at the rate of 32 million cubic feet of gas per day each, and reserves added in 2009 are at 390 bcf gross, or 65 million barrels oil equivalent gross. The western half of Cygnus, where we're going to be appraising two wells in the first half of 2010 could add significant reserves, and then the good thing about Cygnus is, it's going to have long life production.

I'd now like to move to our U.S. exploration drilling program. I'm going to be talking about four well, and first I'd like to talk about the Wolfcamp oil play. This play is in the Southeast of Mexico; it's an emerging oil play. We are extending the play to the Northeast, and the real breakthrough in this play is horizontal drilling and multi-stage tracks. We currently are drilling pilot holes vertically about 8,500 feet, and then we turn the well bore and drill horizontally for a little over 4,000 feet.

We have three wells at various stages of drilling and completion maturity, and there was a geographical spread of these three wells to evaluate the acreage. When we farmed into this acreage in April, we had about 10,000 acres gross. We've been building our acreage position and we currently built our acreage to 17,000 acres. Dual spacing is currently believe to at 160 acres and this gives sufficient room with the 17,000 acres for up to a 100 wells.

Competitors have experience peek production of up to 1,700 barrels of oil per day, reserves per well, (inaudible) to 1 million barrels of oil in gross. The good thing about the oil here is West Texas intermediate type, light sweet crude and fetch premium prices per barrel.

The three wells that we've drilled so far, Lucky Penny is the first one, we spud it in mid-March 2009. However, it countered some billing problems, we only were able to get 2000 feet of horizontal section. Well is currently producing oil, frac fluid and natural gas and it's too early to estimate the productivity.

Our second well is called The Moore Bailout well and we use the lessons learned from drilling the first well, temperament improvements in the well plant from Moore Bailout well. It spud on 7th of August and it's already drilled the vertical hole and we're currently, we've drilled a horizontal and again we only able to get 2000 feet. The well is currently flow testing and producing oil, frac fluid and natural gas.

Third well, incorporated lessons learned from the first two, it spud on October the 10th, and it's currently 10 days ahead of plan. It's just finished drilling the pilot hole and logging and is beginning to drill the horizontal. We'll report on all three of these once we have definitive data in hand.

And lastly I'd like to just give you a brief status of Alligator Bayou, the Armour Runnels number one well. This is a large prospect in the Miocene, it's got about 10,000 acres of closure and we were targeting about lower and middle Miocene sands.

We get to the Lower Wilcox and we're not successful and currently we're waiting on the operator to initiate the testing program at the Middle Wilcox. And the lack of available capital left some participants unable to pay cash cost and this is what has caused the delay.

The Middle Wilcox zones lie between 18,500 feet and 21,200 feet and there are much better porosity and permeabilities in the lower Wilcox. So we are hopeful that this will be a successful when we get a chance to get back to testing.

So, we'll be reporting on this well as soon as we've finish the Middle Wilcox testing. And I'll turn the program over to Bill.

Bill Transier

Thanks John. Let me wrap up by taking three steps, one kind of our U.S. initiatives, second where we are in our U.K. activities and then finally just some overall strategic comments for you to think about.

As we said it couple of times already, we announced last week a small acquisition of some producing and non producing assets in Texas and Louisiana, from the company called J-W Operating.

If you don't know, J-W is a large service in E&P company with a fantastic reputation that's operating in some of the most exciting place in the U.S. We spend a lot of time with these folks and have come to respect the work they do and they add that they positions that they have. I can suggest to you and hopefully you'll see more out of us working here in the near future.

There continues to be a going success in this Wolfcamp area that we talked about, it's too early to say what our production might settle out to be, but I think there is a chance I add sub static [synthetic] oil production price in the near term.

On the acquisition front, there continues to be enormous opportunities for U.S. players like Endeavour in the United States. The challenge has always is the capital that you can accumulate to put to work and for company like Endeavour, we have a lot of good places to spend our capital already, particularly these development projects that Carl talked about earlier.

With respect to our U.K. activity, the development assets are all moving forward with positive momentum. It's always difficult, as a small company synchronizing CapEx and cash flow. Getting to 2011 and starting up our first production is a challenge, we feel confident about and achieving it and we've talked about how we can handle the CapEx to get there earlier in Mike's comments.

I believe and we continue to forge ahead that there is still place in the North Sea for an independent to find substantial reserves and create significant value. There are just not many independents left in the North Sea, so we feel good about our position and we're now seeing lots of things that probably wouldn't have seen earlier. In terms of good quality prospects and a replenishment of the inventory that John has talked about here just a minute ago.

More importantly, we have transformed Endeavour from a pure exploration company in the North Sea to a gas development company and on track to be the largest independent gas producer in the North Sea by 2011. This is a stature that I don't think goes unnoticed by some of the larger European utilities.

Lastly, just respect to some strategic comments. Our stock price continues to remain under pressure. In the second quarter this year, we sold our Norwegian business for $150 million. By everyone’s analysis this was an excellent transaction for Endeavour. We monetize assets out of the high cost, very long cycle and high tax rate environment that provided us with financial security in a very tough time worldwide when many of our smaller cap peer will be enforced out of the business.

We took execution risk, as I call it out of our development projects in the U.K. and gave us the courage to move aggressively in U.S. where we believe opportunities are tremendous to balance our portfolio with onshore with lower risk, lower cost activities.

Just to remind you the sale of our Norwegian operation represented less than 20% of our reserves, but more than the market cap of our company at the time. We’ve only headed to our asset value in this [succeeding] five month since that event while our stock price is slip back to $1 kind of plus level. I can’t explain the stock price and will not complain about how the market treats us, but you can be assured that this management team will continue to create value for our shareholders whenever the opportunity is present itself.

Our production in the U.S. is small but growing. All of you are aware the large ramp up in production in 2011 related to our U.K. development projects. These projects are probably better than we have forecast because of the improving quality of those assets, but we have to begin our strategy to balance that with our U.S. production. We mentioned Wolfcamp area several times, Garwood is still on production and we expect Alligator Bayou to be on production one day.

We have added some production from our recent acquisition of J-W and I can assure you that there is more to come, a lot of these estimate about our exit rate at the end of 2009 in terms of production will be north of 5000 BOEs a day and that will grow to well north of north of 20,000 BOEs a day in 2011, maybe even higher depending on the success that we show you in the U.S.

We continue out exploration appraisal, drilling success, which shows in my view our disciplined and allocating capital. We are now 15 out of 18 since changing exploration leadership back in October of 2007. We actually expect they have another credible year in replacing our production and growing reserves, we won’t be able to announce that till early next year once our reserve engineers are done looking at the reserve additions.

Finally we always stay conscious and focused on our financial position. Mike talked about it, we are strong financially. We paid down a significant amount of debt so far this year. We have a low cost capital structure that we consider quite in terms of its repayment schedules and we have growing credit capacity which takes execution risk our of our development assets.

As always, we appreciate your interest in Endeavour and being on this call with us today and if we could we’ll now open it up for questions to the group.

Question-and-Answer-Session

Operator

(Operator Instructions) Our first question comes from the line of Leigh Curry with Guerrilla.

Leigh Curry - Guerrilla

I’d be interested in hearing a little bit about how the relationship and whatever with J-W originally started? How that came about?

Bill Transier

Lee, as is always in this business friends and people that you work with over the years made an introduction to us. Myself, Bruce Stover and others in the company went to visit with them about their opportunities and some of their existing asset positions in the United States. We leaned a lot of their company and we spent a lot of time talking about our own.

They are interesting because as you know they are a large service company, but they also have also an E&P operation. Those businesses compete for capital and they are continuing to look for a go-to partner in the U.S. to do something and we are interested as you know in building our position in the U.S. and some of the more interesting plays around the U.S. We have got to know these guys, we like the way that they run their business. They are a private company, a very large private company and they are pretty conservative about the way they approach things and we have just spend a lot of time trying to create a relationship with them.

I think you will see more out of us, as we go forward. Obviously we bought a small package of assets from them. As you would hope and expect that’s just the frontend of other things that we are visiting with them about.

Leigh Curry - Guerrilla

Congratulations on moving forward your group of assets in the North Sea and I liked the way you handled your comment about the stock price, that’s not anything that you can do anything about right now, and you are doing the right thing by focusing on running the business over the North Sea and developing new operations here in the U.S. and when I look back you sold the stuff in the North Sea, it amazes me of how underway the stock is. So that’s the end of my editorial there.

Bill Transier

Leigh, thank you for the support, we’re going to continue to try to build value for investors and I thank you for your comments.

Operator

(Operator Instructions) Ladies and gentlemen, this concludes today’s question-and-answer session. I would now like to turn the call back over to Mr. Bill Transier for closing remarks.

Bill Transier

We appreciate all of you being on the call with us here today and as always we are here to answer any follow-up questions that you might have. We wish you a good day and thanks for being involved here.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. Have a good day.

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